SABIC sees 'more challenges' ahead as costs rise

Saudi Basic Industries Corp warned investors on Monday that it saw "more challenges" in 2008 because of higher raw material costs and a possible decline in demand in the United States and Europe.

The world's largest chemicals firm by market value also said it was cutting costs, according to a statement carried by the official Saudi Press Agency (SPA).

SABIC expected "more challenges in light of an increase in the prices of raw materials and chances of declining demand as a result of a slowdown in the economies of the United States and Western Europe to some extent", it said.

Sriharsha Pappu, analyst at HSBC Global Research, said SABIC had to take measure to counter the rise in costs. "Since 75 percent of its costs are from raw materials, they (SABIC) don't have too many options," he said.

State-controlled SABIC also sought to calm investors about the viability of its $11.6 billion acquisition of GE's plastics unit, saying it was a crucial growth step for the company that would generate value in the long term.

SABIC has lost 30 per cent of its value since it ended a record profit run in the fourth quarter as US chemicals demand faltered.

The company's fourth-quarter costs soared 115.7 per cent against a 77 per cent rise in sales. This surge slashed the firm's net margin by more than a third to 17 per cent, which is still far above 12.8 and 12.1 per cent operating margin respectively for competitors BASF and DuPont.

"The surge in costs in the fourth quarter was from GE Plastics acquisition," said Pappu.

SABIC said its purchase of GE plastics unit last year would add value and boost its competitiveness in growth markets in the United States, Europe and Asia, boosting long-term growth.

"SABIC confirms its confidence in the quality of its investments in SABIC Innovative Plastics, according to its long-term strategic plan in which its future growth depends on expansion in specialised products," it said.

SABIC has renamed the GE unit SABIC Innovative Plastics.

The biggest risk to petrochemicals demand would be a severe downturn in economic growth, notably in China, a major engine of global demand growth, HSBC said in a note received on Monday.

SABIC Innovative Plastics and the earlier acquisition of Huntsman's European commodity assets in 2006, would enable SABIC "to create synergies from its ability to source raw materials more cheaply" than the two firms would have done on their own, it added.

Innovative Plastics, with its assets primarily in the United States and Europe, "does not have the unmatched cost advantage that SABIC's facilities in Saudi Arabia do".

"Therefore (Innovative Plastics) has lower profitability," HSBC's Global Research said in a note received on Monday.

For its operations in Saudi Arabia, SABIC has access to feedstock at bargain prices which boosts its margins.

"It would ... be facetious to argue that all incremental investments made by SABIC across the world should be held to the same standard of return that SABIC achieves in its Saudi projects," HSBC said.

Shares of SABIC have plunged 30 per cent since January 19, the day it released its fourth-quarter earnings results. (Reuters)